What is IPO? - Meaning, Types, and Advantages

Initial Public Offerings, popularly known as IPOs, are crucial for any company heading for a listing on the stock exchange. Launching an IPO is a significant step for any business as it allows them to raise capital from investors.

This article simplifies the concept of an IPO and walks you through its meaning, types, functions, eligibility, pros and cons, and what you need to remember before investing.

Table of contents

1. What does IPO mean?
2. Types of IPO
3. How an initial public offering (IPO) works
4. What is the IPO timeline?
5. Pros and cons of investing in IPO
6. What are the eligibility criteria for an IPO?
7. Why does a company offer an IPO?
8. How to invest in IPO?
9. Things to remember while investing in an IPO
10. Terms associated with IPO

What does IPO mean?

An IPO, or Initial Public Offering, is when a company offers its shares to the public for the first time. This process marks the company's transition from being privately owned to becoming publicly traded on a stock exchange.

By going public, the company can raise money from investors to fund to its growth, expand operations or pay off debts. At the same time, an IPO gives investors the chance to buy shares and become shareholders of the company. For a business, an IPO is a major milestone that increases its visibility, credibility, and access to a larger pool of investment funds.

Types of IPO

IPOs in India are typically offered through two main methods—fixed price issues and book building issues—each aimed at helping companies raise capital while allowing investors to participate at a price determined through different mechanisms. Understanding these formats can help investors make more informed IPO decisions.

Fixed price offering:

• The company sets a fixed price for its shares.
• Investors know the share price beforehand.
• To invest, they must pay the full price of the shares while applying.

Book building offering:

• The company provides a price range, called the price band (e.g., a minimum and maximum price).
• Investors place bids, deciding how many shares they want and the price they are willing to pay.
• The lowest price in the range is the floor price, and the highest is the cap price.
• The final share price is decided based on these bids.

How an initial public offering (IPO) works

An IPO involves several structured steps before a company’s shares are made available to the public. From appointing intermediaries and preparing regulatory documents to price discovery and share allotment, the process is designed to ensure transparency, regulatory oversight, and fair participation for investors. Here are some of the processes involved:

• Choosing an underwriter or investment bank: The company hires financial experts to assess its financial health, manage the IPO process, and connect with potential investors.
• Preparing IPO documents: The company prepares a detailed registration statement and a Draft Red Herring Prospectus (DRHP) as per SEBI guidelines. These documents explain its operations, finances, and plans to investors.
• SEBI approval: SEBI reviews these documents to ensure they are accurate and transparent. Once approved, the company can proceed.
• Listing on stock exchanges: The company applies to stock exchanges to list its shares for public trading.
• Marketing the IPO: Efforts like ads, social media and roadshows attract investors.
• Setting the price: The company chooses a fixed price or book building method for pricing shares.
• Bidding and allotment: Investors place bids, and shares are allocated based on availability.

Read Also: How to Invest in Initial Public Offering (IPO)?

What is the IPO timeline?

The IPO timeline outlines the structured sequence from initial planning to public listing, typically spanning several months for mainboard issues under SEBI oversight. This phased approach is designed to ensure regulatory compliance, promote investor transparency, and facilitate efficient capital raising while aiming to reduce execution risks.

• Preliminary stage: The company plans and prepares necessary documents for submission to regulators.
• Approval stage: The regulatory authority reviews and approves the prospectus.
• Subscription period: Investors can apply for shares within a specified timeframe, usually 3-10 days.
• Allotment and listing: Shares are allocated to investor and the company’s stock is listed on the exchange.

Pros and cons of investing in IPO

Investing in Initial Public Offerings (IPOs) presents an opportunity to participate in a company's potential growth from its public debut, but it also carries distinct risks due to limited track records and market dynamics. The following table summarises the key advantages and challenges to aid informed decision-making.

What are the eligibility criteria for an IPO?

Initial Public Offerings (IPOs) in India are regulated by the Securities and Exchange Board of India (SEBI), which sets specific eligibility conditions. These are put in place for investor protection and to ensure orderly market conduct.

These conditions mainly assess the company’s financial performance, business history, and regulatory compliance.

Key requirements for companies planning an IPO include:

Financial performance:

• The company is generally expected to have net tangible assets of ₹3 crore or more in each of the past three full financial years.
• It should have earned an average pre-tax operating profit of at least ₹15 crore in any three of the last five years, with positive operating profit in each of those three years.
• The company should also have a net worth of at least ₹1 crore for each of the preceding three full financial years.

Business history:

• A continuous operational track record of at least three years is usually expected, either by the company itself, its promoters, or a converted partnership firm.

Regulatory compliance and governance:

• The company should not be under review by the Board for Industrial and Financial Reconstruction (BIFR), and there should be no accepted winding-up petitions with the National Company Law Tribunal (NCLT).
• Promoters and directors must meet prescribed integrity standards and should not be classified as willful defaulters or fugitive economic offenders.

Companies that do not meet the profitability benchmarks may still become eligible to list if they reserve at least 75% of their public issue for Qualified Institutional Buyers (QIBs).

Why does a company offer an IPO?

For many companies, launching an IPO represents a significant strategic decision. By entering the public markets, a company can diversify its sources of funding, increase transparency, and expand its investor base. Here are some reasons why a company may choose to take the IPO route:

• Raising capital: IPOs help companies generate funds for expansion, research, and other growth activities.
• Debt reduction: The proceeds from an IPO can be used to repay existing debts.
• Enhanced credibility: Publicly listed companies often gain better recognition and credibility.
• Liquidity for shareholders: Existing shareholders can sell their stakes in the company during or after the IPO.

How to invest in IPO?

Participating in an iPO typically requires a demat account and an active bank account, along with a structured application process through mechanisms such as ASBA or UPI. Here are the steps you may follow to invest in an IPO:

• Open a demat account: A demat and trading account is essential to apply for and hold shares.
• Check for IPO Announcements: Keep an eye on upcoming IPOs through stock exchange websites or brokerage platforms.
• Apply for IPO: Use your broker’s platform or bank’s ASBA (Application Supported by Blocked Amount) service to apply.
• Wait for allotment: After the subscription period, shares are allotted based on demand.
• Start trading: Once listed, you can trade the shares on the stock exchange.

Read Also: What is the difference between NFO and IPO?

Things to remember while investing in an IPO

Investing in an IPO may require diligence and objectivity, as the excitement around new listings can sometimes influence investor decision-making. Prioritising fundamental analysis over market sentiment may help investors make more informed choices based on the company’s business prospects rather than short-term speculation.

• Conduct thorough research: Take time to understand the company’s business model, financial health, industry position and growth potential. Strong fundamentals are a good indicator of a promising investment.
• Read the prospectus carefully: The IPO prospectus is a detailed document that provides valuable insights about the company’s operations, financials, objectives and risks. Reading it will help you make an informed decision.
• Understand the risks: Every investment carries risks. Assess market conditions, industry trends and factors that could impact the company’s future performance before committing your money.
• Avoid oversubscription hype: High demand for shares doesn't always mean high returns. Stay objective and don’t invest solely based on market buzz.
• Have patience: IPO investments often yield better return potential over the long term. Avoid expecting instant profits and focus on the company's long-term growth potential.

Terms associated with IPO

Understanding key IPO terminology may equip investors with the language of public offerings, enabling clearer navigation of prospectuses and application processes. These terms define structure, pricing, and participation rules.

• DRHP: Draft offer document filed with SEBI containing details on business, financials, risks, and issue objectives; may be made available for public comments before finalisation.
• RHP: Offer document filed with the Registrar of Companies before the issue opens, containing most disclosures but excluding the final issue price (in book-built IPOs); used during the bidding period.
• Price Band: Price range (floor and cap) for book-built IPOs within which investors place bids; final issue price is decided based on demand.
• Lot Size: Minimum number of shares an investor must apply for (and in multiples thereafter), as specified in the offer document.
• ASBA: Application mechanism where the bid amount is blocked in the investor’s bank account until allotment, ensuring funds remain with the investor until shares are allocated.
• Anchor Investors: Large institutional investors allotted shares (up to 60% of the QIB portion) one working day before the issue opens, helping provide early demand visibility.
• OFS: Portion of the IPO where existing shareholders sell shares; proceeds go to the selling shareholders, unlike a fresh issue where funds go to the company.
• Listing Gain/Loss: Difference between IPO issue price and listing price on the stock exchange.

Conclusion

An Initial Public Offering (IPO) can benefit both investors and companies. For investors, it’s a way to be part of a company’s growth journey. For companies, it’s an opportunity to raise funds and reach new goals. However, IPOs also carry risks, just like any other investment. By staying well-informed and making thoughtful decisions, you can maximise the potential of investing in IPOs.

FAQs

What is the full form of IPO?

IPO full form is Initial Public Offering.

Is IPO profitable?

While IPOs can be profitable, they also carry risks. Profitability depends on the company’s performance and market conditions.

How to sell IPO shares?

Once listed on the stock exchange, IPO shares can be sold through your trading account from the stock exchange.

Is IPO a stock or a share?

An IPO represents shares of a company being offered to the public for the first time.

How is an IPO priced?

IPO pricing is determined either through a fixed price method or a book-building process based on demand and supply.

How is IPO profit calculated?

IPO profit, often referred to as a listing gain, is calculated by subtracting the issue price (the price at which shares are allotted) from the listing price (the price at which the shares begin trading), then multiplying the result by the number of shares allotted. For example, if you are allotted shares at ₹100 and they list at ₹120, your gain would be ₹20 per share.

What is an IPO in simple terms?

An Initial Public Offering (IPO) is when a private company offers its shares to the public for the first time. This allows the company to raise capital for business expansion. The investors get a chance to become shareholders and potentially benefit from the company’s future performance.

Is it good to buy in an IPO?

Investing in an IPO can be beneficial as it provides early access to a company’s shares. One of the benefits of IPO is the potential for long-term growth. However, IPOs can experience sharp price movements.

Who can invest in IPOs?

In India, IPOs are open to several investor categories, including resident retail investors, non-institutional investors, and qualified institutional buyers (QIBs). To apply, an individual generally needs a PAN card, a Demat account, and a bank account linked to UPI for payment.

What is an IPO in the stock market?

In the stock market, an IPO represents the process through which a private company becomes publicly listed by offering its shares to investors for the first time.

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